The law places on a director onerous responsibilities concerning his company.
When contemplating a buyout of the company or part of its business, the director will also be considering his position as a future shareholder.
This can create a conflict of interest which needs careful management.
DUTIES OF THE MANAGEMENT
1. Fiduciary duties
The fiduciary duties which a director owes to his company are founded on a simple concept that a director must act not only honestly, but in the interests of his company and not in his own interests.
Directors are bound to use fair and reasonable diligence for the management of the company’s affairs and act honestly.
2. Conflicts of interest
One of a directors fiduciary duties of particular relevance in a management buyout is that he must not put himself in a position where his duty to the company may conflict with his personal interest.
The duty arises from the real concern that the management may benefit from an opportunity which properly belongs to the company and its shareholders.
The breach of duty consists not of allowing the conflict of interest to arise because that if often outside the control of the director, but of the director preferring his own personal interests to those of persons for whom he acts as fiduciary, or of taking advantage of such a position.
For example, the director must take care not to withhold from the company’s shareholders information that would, if provided to them, enable them to negotiate a fairer price for the company.
It is not unusual to see management prepare one business plan and profit projections for the benefit of the company’s owners, to be used by them in determining the price at which they will be prepared to sell and another more optimistic plan and projections for themselves and for their funders.
3. Secret profits
The obligation of directors to account for profits made as a result of abusing (in the sense of taking advantage of) their position as directors is often described as the principle that directors must not make a secret profit.
It arises directly out of the "no conflict" rule, of which it is a logical consequence.
If a director cannot keep the benefit he would obtain were he to take advantage of his position, he will not be tempted to take advantage.
Despite the general principles set out above, a director may participate in investment opportunities and transactions in which his company is participating, provided that the articles of association of the company permit and provided the board has independently decided upon the amount of its investment and the amount being raised requires the participation of other persons on terms no more favourable than those offered to his company.
In short, the directors are not legally restrained from appearing on both sides of the bargaining table, but they must observe the necessary processes.
4. Statutory duties
In addition to fiduciary duties, a director is also subject to a number of statutory constraints and obligations.
Disposals to directors
The Companies Act 2006 (sections 190 to 196) allows a company to enter into contracts with its directors, provided they are conditional on shareholder approval where there is a substantial property transaction. Therefore provided the substantial property transaction is approved by the shareholders of the company either at the time that the transaction takes place or is approved subsequently then it is possible for the company to dispose of substantial assets to one or more of its directors.
Section 191(2) sets the de minis threshold for the meaning of "substantial" at anything over £5,000.
Therefore the company has the ability to make an agreement conditional upon shareholder approval being given for the transfer of any non cash asset to the value of more than £5,000 to a director or directors.
Disclosure requirements
Section 177 of the Companies Act 2006 relates specifically to directors declaring their interest in transactions or arrangements which are proposed but have not yet been entered into by the company.
Section 182 deals with the declaration of interests in relation to existing transactions or arrangements that the company has already entered into.
Therefore, in both cases the directors have a duty to declare their interest in transactions and arrangements whether these are proposed or existing.
Duties under a service agreement
It may well be that you have service agreements with the Company.
Such a contract usually emphasis the directors duty to act in the best interests of the company.
It may also expand the common law duties of the director and add other responsibilities.
If no service contract exists, then the director will hold office on the terms set out in the company’s Articles of Association.
Therefore, it is very important that you read again your service agreements before embarking on a management buyout to ensure that you know what your express duties are.
If the company and its shareholders are aware of the management buyout then there may not be any issues.
However, if the selling shareholders do not know about the proposed management buyout then you as members of the management team could risk action against you for breach of your service agreements.
For example, the service agreement will almost certainly require the directors to spend all his working hours working for the business.
Speaking to venture capitalists, accountants or lawyers about business plans or any other aspect of the buyout does not amount to working for the business and if done in working hours may be in breach of the service contract.
Secondly, a director is likely to be restricted by his service contract for competing with his employer at any time whilst employed by the company and probably for a short period afterwards. Such a provision would prevent him from making, whilst still employed, preparations for competing after the termination of his service agreement.
However, as already stated above, if the selling shareholder is aware of the management buyout then this should not be an issue.
Duty of Confidentiality
Funders (including Venture Capitalists and Banks) will need spend a considerable amount of time with the management team before an offer is made to the selling shareholder.
In order to make their decision regarding the funding, they will need access to financial information available to the management but not publically available, as well as the management projections for the future.
Information of this nature is confidential and is the property of the Company.
Management accounts, trade secrets of the business, plans or opportunities for the future cannot be released without the approval of the selling shareholder.
To do so would put the management team at risk of losing their employment and even facing a claim for damages if release of the information caused financial loss to the business. The management team would also risk breach of their fiduciary duties to act in the best interests of the company rather than in their own.
Therefore, it is important to keep the selling shareholder aware of all negotiations and discussions which are taking place with funders and what information that is being released to them and ensure that their permission is given for such information being released.
If you have any queries regarding this note on your duties please do not hesitate to contact Richard Murrall on 01952 21046 or email richard.murrall@lblaw.co.uk.or Ruth James on 01952 211008 email ruth.james@lblaw.co.uk